NPV of a project

rbcc

Junior Member
Joined
Nov 18, 2009
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126
Hi, I'm having trouble with this question

A firm has provided you with the following data:

initial cost of a project 1500
CCA rate is 10%
the discount rate is 7%
tax rate is 20%
the cash flow in the first year is $700 and will increase at 4% for 4 years
At the end of the 4th year the project will end, the machinery will be scrapped ( no salvage) but the asset class will continue.

calculate the NPV of the project

Cash flows before tax( the question doesn't say but I'm assuming these are before tax cash flows...)
year 1 700
year 2 700*1.04=728
year 3 728*1.04=757.12
year 4 757.12*1.04=787.4048

It says that the project will be stopped at the end of year 4 so there would be no year 5 cash flow, but that means that cash flows increased for only 3 year as opposed to 4 years that they mentioned in the question right?

PV of After tax cash flows would be
700*(1-0.20)=560/1.07= 523.36
728*(1-0.20)=582.4/1.07^2= 508.69
757.12*(1-0.20)=605.696/1.07^3= 494.43
787.4048*(1-0.20)=629.92/1.07^4= 480.56

Sum=2007.047

Present value of the cca tax shield
=(inital cost*cca rate* tax)/( cost of capital + cca rate)*[(1+0.5cost of capital)/1+cost of capital] - [(salvage*cca rate*tax)/(cost of capital +cca rate)]*(1/1+cost of capital)^n)
=(1500*0.10*0.20)/(0.10+0.07)=176.47 since there is no salvage

and inital cost is 2500

so NPV= -2500+176.47+2007.047=-316.483

but the solution gives another answer...


thanks
rbcc
 
Last edited:
oh wait i think I know, is it because there is no salvage so you cant use the normal CCA tax shield formula?
 
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